From time to time, I like to take the suggestions of my readers in regards to what companies I will look into next. Not only does this satisfy their curiosity regarding my thoughts on the business but it also gives me the opportunity to see whether the business in question makes for an interesting prospect for my fund. In this piece, I decided to do just this with a small E&P operator called Mid-Con Energy Partners LP (NASDAQ:MCEP). With a market cap of $26.8 million, it's smaller than the vast majority of companies I look at (generally with market caps ranging from $100 million to $10 billion (though I have no problem looking at those outside this range)), but this little operator may just be one of the best upstream energy companies out there if they can work a little magic.
A look at Mid-Con
Founded in 2011 in Delaware, Mid-Con is a developer of oil and gas reserves through parts of Oklahoma, Colorado, and Texas. Since some of its production comes from the Permian Basin, the entity's wells have low decline rates compared to many of the shale drillers located in other regions. Most of the company's production (about 94.2% by my calculations) comes from the sale of oil, making this decline in the energy environment devastating to investor sentiment. Prior to this downturn in energy prices, Mid-Con's share price (looking back only through 2014 since that is when the downturn began) traded as high as $24.25 apiece. Today, after seeing the price of oil and natural gas plummet from over $100 per barrel to $31.77, and after the company sold at least 8.6 million shares to the public (diluting its owners by nearly 41%), the stock is now going for just $1.08.
In my analysis of the business, I will use a WTI price of $31.77 and, for the price of natural gas, $2.383 per Mcf. These prices will be used in perpetuity so any fluctuation in the actual prices of oil and natural gas could materially alter the company's actual results. I will also assume that the company's 2015 mid-point guidance of 4,700 boe (barrels of oil equivalent) per day is achieved and that its other cost items come in line with management's forecasts moving forward. I've also included in this analysis the company's most recent price differentials for oil, which total $5.86 per barrel.
The simple math
Based on the assumptions I made, the situation facing Mid-Con appears fairly straightforward. If management is correct in its assumptions, Mid-Con should generate sales this year of about $90.59 million, the vast majority of which should be driven by oil. As hedges roll off partially in 2017, the company's revenue will fall pretty hard to $60.27 million before hitting rock-bottom at $43.29 million in 2018 once all of its hedges are gone. Obviously, the outlook for a company whose sales will fall by nearly half over the next couple years is not good but when you consider that 2018 doesn't begin for almost two more years, that provides the oil market plenty of time to recover.
Fortunately, from a cost perspective, the situation facing Mid-Con is pretty good. Using management's forecasts, the company's cash costs for should come out to $59.65 million but I suspect that management will be able to push these costs lower to some extent. Even after that, however, Mid-Con is slated to bring in cash flow for 2016 of $30.93 million. Given the company's small market cap, this implies a price/free cash flow multiple of only 0.87, among the lowest I've ever seen.
So far, the situation looks quite positive for the company but the good news fades after 2016. If the energy market does not improve, cash flow in 2017 will total $0.62 million, followed by a cash outflow of $16.37 million in 2018. The positive thing, though, is that not a lot has to happen in order for Mid-Con to break even without its hedges in place. Keeping all else the same, including natural gas prices, the company should break even if oil prices average just $43.10 per barrel in 2018. If this happens in 2017, cash flow should be a positive $9.03 million. In a world where oil prices climb to $70 per barrel, a number that I think we will likely hit late this year or sometime in 2017, Mid-Con's 2018 cash flow would come out to $39.09 million, more than enough to make the business a five-bagger if nothing goes materially wrong.
The one issue I have with the company, however, relates to its credit facility. Right now, the company is being forced to decrease the $180 million it has borrowed to $150 million by the start of May of this year. Looking at quarterly data, I calculated that the company should generate cash flow of around $9 million during this timeframe, which implies that management still needs to come up with $21 million in excess cash, a number that is in line with some other authors on Seeking Alpha like JSG_DRIP. Given the tough environment for energy, this kind of capital won't be easy to come by, especially for a business as small as Mid-Con. However, in addition to the ideas looked at by JSG, the company could also consider asset sales, debt issuances, and extreme cost-cutting (the least likely method to get them the shortfall they need in such a short period of time).
Currently, the picture for Mid-Con from a cash flow perspective appears very positive for this year but the situation does begin to deteriorate next year. The other (and much larger) problem relates to the company's credit facility borrowings, which could push the entity to an early grave. On the other hand, I really am impressed with the company's low cost structure and I am more bullish on crude prices than the majority of people out there so I ultimately believe the risk-reward payoff (for me at least) is positive.
This isn't to say that investors shouldn't be concerned because the fact of the matter is that their credit facility issue is material in nature. However, given the company's otherwise sound finances, I believe the chances of them solving their shortfall is fairly high. If, on the other hand, this does not transpire or if the energy market does not show signs of a recovery by the end of this year, the low cash flow the company will bring in during 2017, combined with the likelihood of their lenders becoming even more impatient as time goes on and hedges roll off suggests that Mid-Con would be very unlikely to survive through 2017 as is.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.